Introduction:Blanka Doborynin a managing partner of AURORA BOREALIS LLC tries to initiate a research for a potential investment in Wrigleys. They are trying to recapitalize the firm. Wrigley’s which is 100% equity financed has a market value of $13,103,000,000 the question begins if it is totally equity financed is it running at its efficient level? Or Is it better to recapitalize the structure and thereby bring out more efficient operational levels. They are planning to get a debt of 3,000,000,000 using it to extract the profit out of the low risk (BBB) forecast that the company possesses. They are potentially investigating, if it is good to recapitalize is it right to repurchase the shares with the debt or to pay dividends with the entire debt.

There are major changes that take place in the following list of questions given to us and the following answers are answered according to the questions order. The answers are tabulated below. | Dividends| Repurchase of stock|

Outstanding shares| 232,440,000| 183,686,000|
Book value of equity| $(1724)| $(1724)|
Price per share| $48.63| $61.53|
Earnings per share| 0.32| 0.40|Table 1: describes the effect of issuing debt and using the proceeds to pay dividend or to repurchase stock.The number of outstanding shares in Wrigley’s would vary only if the shares were to be repurchased. The number of shares remaining after the repurchase is 183,686,000 i.e. a change of 48,754 shares.

The book value of equity is the difference between the book value of assets and the book value of liabilities.From ExhibitTN2 we come to know that the book value of equity becomes negative. Negative book value to equity should not be used for taking decisions in the business because it uses historical data. It does not say anything about the risks faced by the companies (negative book value does not mean a risky situation). Hence business decisions should be taken wisely with respect to market value of equity. The Book value which is calculated according to accounting standards does not consider the increase in the value of equity brought about by Tax shield or the current trend in the market which is considered in the market value of equity.

The price per share changes significantly if the company pays dividends and if it repurchases stock. If the company pays dividends, the price of each share is $48.63. This decrease in the value of the stock is because as debt increases with the same amount of share holders then the value will drop as $3 billion out of the capital structure transfers to the debt holders. Price of the share on repurchase increases to $61.53, The reason is according to MM theory the value of levered firm is higher. This is because of tax shield playing an important role; This extra value is reflected on the shareholders asset.

The question at this point maybe, why does value increase in the case of repurchase and decrease when the company pays dividend? The answer is pretty straightforward the number of shares that the company holds explains the answer (refer ExhibitTN 2)

With reference to Exhibit TN7 which is the comparison between EBIT and EPS at various levels of operational income. Where the operational income for 2001 (514 million) was used under the year 2001in the XL sheet and various calculations were made. After recapilazation i.e. getting $3 billion in debt, the Earning per share reduces from 1.33 to .40 for repurchase and .32 if the company decides to pay dividends. Adding to that, with respect to the graph we can see that EPS of repurchase is higher than EPS of dividends paid. The reduction in EPS is due to the fact that there is a reduction in the number of shares after repurchase. The interest expenses raises which reduces the earnings for the shareholders when the dividends are paid.

...CAPITAL STRUCTURE, VALUATION, AND COST OF CAPITAL
Executive Summary
Aurora Borealis LLC is an activist Hedge fund. They are trying to buy a large stake in the company and thereby force the management to reorganize the capital structure by raising the debt and using it to pay the dividends or buy back the shares. The effect of restructuring on various financial parameters will be discussed in the concluding parts.
Hedge Fund Strategy
The buyback of shares would increase the EPS for the firm as a natural consequence of reduction in number of shares outstanding. The increase in EPS will signal towards a positive market sentiment, which would result in increase in share price. Also, raising debt at lower cost of debt i.e. at good credit ratings lowers the WACC due effect of the tax shield and hence the value of the firm. Aurora Borealis LLC, like any other hedge fund, banks on instantaneous rise and fall in stock prices than the long term investment in growth and stability of the firm. The hedge fund plans to short the stock at the moment it rises to the optimal level due to strong signals the hedge fund is trying to pursue.
Effect of recapitalization on WACC
The current WACC of Wrigley is 10.9%. Since it is all equity firm the WACC is same as cost of equity. Raising $3billion debt for repurchase of stock or dividend would change the capital structure of the firm. The raised debt, because of the debt tax shield under good credit...

...﻿The William WrigleyJr. Company
Case Report
Ying Suan Lo
Julianne Mills
Nick Lim
Vinson Chen
Glen Hamilton
Table of Contents
1.0 1.0 Introduction
Identifying opportunities for corporate financial restructuring was typical for Blanka Dobrynin, a managing partner of the hedge fund Aurora Borealis LLC. In 2002, with the then debt free William WrigleyJr.Company (Wrigley) in her sights, she asked her associate Susan Chandler to conduct research on the impact of a $3 billion debt recapitalisation on the company. This case report aims to make an informed recommendation on whether Wrigley should pursue the $3 billion debt proposal.
2.0 Optimal Capital Structure
According to Miller and Modigliani’s (1958) first proposition, the value of a firm is independent of its capital structure, assuming no corporate taxes. It was later demonstrated that the existence of debt in the capital structure creates a debt shield that increases the value of the firm by the present value of the tax shield (Miller & Modigliani, 1963). This line of reasoning implies that debt financing adds significant value to the firm and an optimal capital structure occurs with 100% debt. However, this is an unlikely outcome in reality with restrictions imposed by lending institutions, bankruptcy costs and the need...

...considers the possible gains from increasing the debt capitalization of The Wm. WrigleyJr. Company. Blanka suggests Wrigley raise the amount of $3 billion in debt of the capitalization while Wrigley has been conservatively financed and remained no debt at the end of 2001. This report is aiming to analyze whether Wrigley should use $3 billion debt recapitalization to either pay dividends or to repurchase shares.
2.0 Current Capital Structure
Generally, firms can choose among various capital structures in order to maximize overall market value of the company. It is proposed however, that Wrigley issues $3 billion in debt.
According to the trade-off theory, the optimal capital structure does exist (Kraus and Litzenberger, 1973). The higher level of debt may increase both bankruptcy and financial cost that lead the firm to go or avoid bankruptcy. However, there are several advantages of raising debt capital. Firstly, tax-deductions which decrease the cost of debt. Secondly, stockholders do not have to share the profit when the firm has excess, as debt holders are limited to their fixed return. Finally, stockholders do have voting right but debt holders do not which means the stockholders are controlling the business.
3.0 The Impacts of Proposed Changes
The decision to increase $3 billion debt capitalization of the Wm....

...share-repurchasing results in a change in Wrigley’s voting control. As such, following a re-purchase of 48.8m shares, various approaches have shown a boost in Wrigley’s voting power from 46.6% to a majority vote of above 51%.
Summary
The issuance of $3bn debt to the Wm. WrigleyJr. Company can be seen to cause a structurally significant impact on both the short and long term operations. As such, there are many implications that have been taken into consideration as to the viability and subsequent sustainability of the debt issue.
The analysis has shown that by re-structuring, Wrigley’s as a company will be affected in several distinct ways. In regards to cost of capital, WACC was seen to increase by 0.01% which indicates the possible insufficiency of the debt shield to offset the cost of interest payments. This, along with an increased likelihood of financial distress, and the introduction of agency costs (brought about by a higher beta) has placed Wrigley’s with a non-investment grade rating of B/BB.
While these may seem detrimental in the short term, long term estimates point to an increased benefit. As debt is serviced into perpetuity, the continuous growth in earnings (with Wrigley’s being an established company within the market, operating in a low technology industry, and consistently sustainable growth) will greatly reduce the probability of financial distress and...

...﻿
The Wm. WrigleyJr. Company: capital structure,
valuation, and cost of capital
Teaching Note
Synopsis
In June 2002, a managing director of an active-investor hedge fund was considering the possible gains from increasing the debt capitalization of the Wm. WrigleyJr. Company. Wrigley had been conservatively financed and at the date of the case, carried no debt.
The tasks for the student are to:
Estimate the potential change in value from relevering Wrigley using adjusted present value analysis.
Assess the impact on the weighted-average cost of capital, earnings per share, the credit rating of the firm, and voting control of the Wrigley family.
Consider the merits of dividend or share repurchase as a means of returning cash to shareholders.
The case’s central teaching objective is to explore the financial effects of the capital structure change. Significant here is the trade-off between the tax benefits of debt and the associated costs in the form of financial distress and loss of flexibility. Related issues include signaling to investors, clientele effects (control considerations for the Wrigley family), and incentives created for directors and managers. Finally, the case affords a comparison of dividends and share repurchases.
Suggested Questions for Advance Assignment
1. In the abstract, what...